Some people say that Forex is recession proof and others that say it's not. Let's take a look at this important question and find out which side is right.
Forex trading is recession proof because traders can select from a wide variety of currency pairs and go long or short, with equal ease. Even a global recession affects individual currencies differently, so there will always be an opportunity to make money. A recession also increases volatility in the currency markets, leading to even more trading opportunities.
Now I'll dig deeper into why Forex is such a good market to trade in a recession, and the definition of a recession.
What is a Recession Proof Market?
A recession proof market is a market that provides equally good trading/investment opportunities, regardless if there is a recession or not.
It's actually easier to define a recession proof market by starting with a market that isn't recession proof. For example, the real estate market is heavily affected by the overall health of the local economy.
When the economy isn't doing well, then many people are out of work and they don't buy houses. On top of that, real estate investors make the most money when property values go up.
You cannot make money while real estate values are dropping. Well, technically there are ways to do it, but they are not nearly as easy to implement as buying a cashflow property or buying and holding an appreciating property.
Therefore, real estate has severe restrictions when it comes to making money on a depreciating property.
On the other hand, in a market like Forex, it doesn't matter if there is a recession or not because you always have opportunities to make money.
It's equally easy to go long or short, and there aren't any restrictions when prices go down.
What Happens to Forex in a Recession?
There are many things that can happen to individual currencies during a recession.
That's the beauty of trading Forex.
Even in a global recession, different currencies will be affected to varying degrees, and in different ways. On top of that, since single currencies are paired in different combinations, you have the opportunity to pick the pair that best matches your trading strategy.
For example, let's take a look at what happened during the 2008 global financial crisis, also called The Great Recession.
The events related to this recession roughly happened between 2007 and 2010, so let's examine this time period. First, here's what the S&P500 looked like on the weekly chart. The blue vertical lines mark the beginning and end of the period we are examining.
The S&P500 dropped from a high of about 1576 to a low of 666. I'll get into why the US stock market is not recession proof in the next section.
But for now, I'm showing you the chart, just to give you a point of reference.
Now let's take a look at the weekly chart of the Australian Dollar versus the Swiss Franc during this time. These charts are pretty correlated, so if you wanted an easier way to trade the S&P500 short, you could have done it through this currency pair.
But other currency pairs reacted differently during this time period. For example, this is what the USDCAD pair looked like. It's not exactly an inverse of the chart above, but it's pretty close.
When you compare the volatility of these 2 charts, you see that the AUDCHF was more volatile than the USDCAD from 2007 to 2008. But AUDCHF was less volatile from about 2008 to the end of 2010.
So although the price action was similar, it was not exactly the same. You could have chosen to trade one or the other, depending on which currency pair was a better fit for your trading strategy and risk tolerance.
If you don't have a trading strategy yet, be sure to take our free Forex Quikstart course for beginners and learn how to develop a trading strategy that works well for you.
The US Stock Market in a Recession
Now let's dig deeper into the difference between Forex and the US stock market in a recession.
Stock trading is different from currency trading.
When you trade stocks, you have to pay close attention to the overall market sentiment and the performance of each sector because they can have a huge impact on the performance of individual stocks.
If the overall market is bearish, then it's generally better to stay in cash or look for shorting opportunities. Since you cannot short all stocks, it can be difficult to find profitable opportunities in a down market.
Therefore, stocks are not recession proof.
Sure, there might be some stocks that outperform the markets in a recession, but they are few and far between…and always risky to trade.
Shorting the stock market via Exchange Traded Funds (ETF) is possible, but can also have risks, due to management fees.
The Futures Market in a Recession
Another way to trade during a recession is to trade the futures markets. I consider the futures markets recession proof because it's pretty easy to trade long and short in most markets.
You can also trade a wide variety of products and contracts.
However, the futures markets can have the following drawbacks, when compared to Forex:
- Less liquidity
- Can get locked limit up/down
- Potentially higher commissions per trade
- Higher minimum account balance because of higher margin requirements
So you can certainly trade futures during a recession, but it's not as easy to trade as Forex.
What is a Recession?
Any discussion on recession proof markets isn't complete without the definition of a recession.
The National Bureau of Economic Research (NBER) determines if we are in a recession or not. They used to define a recession as a decline in Gross Domestic Product (GDP) for at least 2 consecutive months, but that is no longer the case.
The current definition of a recession can be found in their Recession Dating Procedure here.
It states:
“A recession is a significant decline in activity spread across the economy, lasting more than a few months, visible in industrial production, employment, real income, and wholesale-retail sales. A recession begins just after the economy reaches a peak of activity and ends as the economy reaches its trough. “
That's not an exact definition, but there are a lot of economic indicators out there to take into account. So only focusing on 1 or 2 metrics does not make sense.
Looking at many different economic inputs gives us a more accurate view of how well the economy is doing as a whole.
What is a Depression?
So what's the difference between a recession and a depression?
Like with a recession, there isn't an exact quantitative definition of a depression. But generally speaking, it's a longer and more severe version of a recession.
Some people used to define a depression as a 10% or greater drop in GDP, but that definition is no longer used.
A Final Word of Warning
Just because a market is recession proof, does not mean that you will always be able to make money in that market. You'll need skill and a proven trading method to consistently make money in Forex.
There is always risk in trading.
But if a market provides good opportunities, regardless of overall economic conditions, it can be a great market to specialize in.
If you don't have a proven trading strategy yet, then don't start trading until you do. Find a trading strategy by taking our free Forex Quikstart course.
It will take you through the basic steps that you need to know to develop rock-solid confidence in a trading strategy that matches your personality.
Then go to our Strategies page to get some ideas on strategies that might work for you.
We have tested several strategies and show you the results.
Conclusion
Forex is a great market to trade because you can trade very small position sizes, there's a lot of liquidity, and it's equally easy to go long or short. This makes it one of the most recession proof trading markets available.
Luckily, Forex is also an easy market to backtest. That's the easiest way to understand what happens to individual currency pairs during a recession.
You don't have to test thousands of individual stocks or worry about using different contract months, like in the futures markets.
Get started with our Complete Backtesting Guide here.
